US Dollar Testing More Bullish Waters, US Jobless Claims, Philly Fed Disappoints as Usual

Demand for US dollars remains high as investors seek out “safe haven” assets amidst increasing volatility. Indeed, the trade-weighted US dollar index (DXY) closed above key resistance at 88 for the first time since 2006. While it would take a rally above the October 24 and November 7 highs of 88.79-88.91 to say we have a true breakout, it may only be a matter of time as the CBOE’s VIX volatility index closed at its highest level on record, while flight-to-quality has led Treasury yields on two, five, and 10-year notes and 30-year bonds to their lowest levels since the Treasury began regular issuance of the securities. Other indications of risk aversion could be found in the stock markets, as the major indexes all fell more than 5 percent. More specifically, the Dow Jones Industrial Average closed at its lowest level since 2002 and the S&P 500 finished at 11+ year lows.

Meanwhile, US economic data was disappointing as the Philadelphia Fed’s manufacturing index fell sharply during the month of November to the lowest level since 1990. The outlook for this sector is bleak amidst a combination of waning domestic and foreign demand, which should only contribute to additional job losses. In fact, this morning’s release of employment figures showed that initial jobless claims rose to the highest level since 1992 while continuing jobless claims broke the 4 million mark for the first time since 1982. Clearly, increasing filings for unemployment benefits doesn’t bode well for the unemployment rate, which already sits at a 14-year high of 6.5 percent. There are no key US releases due to hit the wires on Friday, making it all the more important to see if the US dollar can break above key resistance, or if the currency will simply back down.

Euro Could Break Below 1.24, Swiss Franc Taken Aback by SNB’s Surprise 100bp Rate Cut

The euro slumped throughout the day on Thursday, but for what it’s worth, EUR/USD is still in consolidation mode. This may not last for much longer, though, as mounting volatility is bound to trigger breakouts in the currency markets. At the time of writing, EUR/USD was trading just above trendline support near 1.2430/50, but a drop below there could lead the pair down for a test of the October low of 1.2328. Meanwhile, the Swiss franc remains in a clear downtrend following the Swiss National Bank’s surprise 100bp cut to their 3-month Libor target range to 0.5 percent - 1.50 percent. Indeed, the SNB was not even scheduled to meet again until December following their participation in the October 8 coordinated rate cuts with the Federal Reserve and European Central Bank, among others. The SNB cited expectations for inflation to fall below their 2 percent target before year-end as well as the deterioration in international economic conditions as reasons for the reduction. With the Swiss economy likely to be hurt by a broader European recession, there is potential for the SNB to cut rates again in 2009. Looking ahead to the next 24 hours, the Purchasing Managers' Index (PMI) readings for the Euro-zone's manufacturing and services sectors are forecasted to hold below 50 - signaling a contraction in business activity - for the sixth straight month. Euro-zone GDP figures have already signaled a recession for the region, as GDP fell 0.2 percent during Q2 and Q3. As a result, these PMI results will provide a gauge as to the depth of this recession, and could suggest that the initial Q3 GDP reading may be revised even lower on December 4.

British Pound Tumbles 1.5%, May Fall to November Lows as Markets Price in 75bp Cut in December

The British pound tumbled 1.5 percent against the greenback on Thursday, despite the smaller-than-expected decline in UK retail sales, as interest rate expectations for the Bank of England continue to plummet. In fact, Credit Suisse overnight index swaps are now fully pricing in a 75bp reduction to the Bank Rate in December to 2.25 percent, the lowest since 1932. Meanwhile, UK retail sales fell 0.1 percent in October, keeping the annual rate low at 1.9 percent. However, the BOE has said in the past that they may focus more on private surveys, such as BRC retail sales, over government statistics as the latter tends to be extremely volatile. The latest BRC same-store retail sales index plunged 2.2 percent in October from a year earlier, suggesting that the BOE still holds a bearish view of UK consumer spending.

Japanese Yen Remains Strong as S&P 500 Falls to Worst Levels Since 1997, BOJ to Leave Rates Unchanged

The Japanese yen generally remains below its October 24 highs, but looks likely to push even higher as volatility climbs to record levels and US stock markets tumble. In fact, the major equity indexes all fell more than 5 percent, with the Dow Jones Industrial Average closing at its lowest level since 2002 and the S&P 500 finishing at 11+ year lows. Investor sentiment has been the key trend we’ve been following in the forex markets, as bouts of risk aversion that lead equities lower tend to benefit the Japanese yen. According to our latest forex correlations report, the correlation between USD/JPY and the Dow is near the highest levels in at least 20 years, and with stocks likely to fall even lower, the outlook suggests the Japanese yen could gain much more.

In economic news, the Bank of Japan was one of the least-followed central banks around just a few months ago, but given their surprise 20bp rate cut last month to 0.30 percent, the BOJ now has the market's attention. Tonight, the BOJ is expected to leave rates unchanged, but it will be important to get a sense of what the Monetary Policy Committee expects for growth and inflation going forward. Bearish investors are betting that many central banks will move towards Zero Interest Rate Policy (ZIRP) in coming months, a policy Japan implemented in the 1990's and essentially stuck with until July 2006. This speculation has only been exacerbated by the Swiss National Bank's surprise 100bp rate cut to 1.00 percent, as the SNB was not even scheduled to meet again until December following their participation in the October 8 coordinated rate cuts with the Federal Reserve and European Central Bank, among others. If global rates are indeed moving towards zero, Japan would logically be the first to get there once again since rates are already extremely low at 0.30 percent.

Terri Belkas is a Currency Strategist at FXCM.